COMPREHENSIVE PROBLEM $[$LO$1-$ C$3$; LO$2-$ CC$5,6,71$

Allen Moving and Storage prepared the following income statement for $2018$:

CHECK FIGURE

$(2)$ Break$-$even sales

$=$ $$4,838,485$

Revenues:

Local: $$1,433,500$

Intra$-$province: $$510,000$

Inter$-$province: $$2,490,500$

Containers: $$333,000$

Packing: $$437,000$

Storage: $$289\mathrm{.}000$

Total revenues: $$5,493,000$ Less expenses:

Outside vehicle repair: $ $220,000$

Fuel: $$352,000$

Sales commissions: $$102,000$

Tires, oil, lube: $$20,500$

Wages $($driver and helper$)$: $$1,584,000$

Internal maintenance: $$293,000$

Advertising: $$88,000$

Equipment rental: $$422,000$

Packing materials: $$557,000$

Salaries: $$821,000$

Cargo loss claims: $$234,000$

Utilities: $$16,700$

Insurance: $$44,000$

Fuel taxes and tariffs: $$132,000$

Bad debt: $$193,000$

Depreciation: $$205\mathrm{.}000$

Total expenses: $$5,284,200$

Operating income: $ $208,800$

Less: Taxes $(42\%)$: $87,696$

Net income: $ $121,104$ Upon reviewing the income statement for $2018,$ chief financial officer Suzie Allen called a meeting to discuss the company's financial status. She invited sales manager Heidi Strom and controller Gautam Singh.

Allen: Our before$-$tax income has dropped from a high of $12\%$ of sales to about $4\%$ this last year. I know that both of you are aware of our problem and have some suggestions on how we can improve the situation.

Strom: Suzie, competition has become quite intense in our industry. I have two suggestions to help improve sales.

First, we need to increase our advertising budget. We have a good reputation, and I think we need to capitalize on it$.$

I suggest that we emphasize our expertise in crating electronic equipment and other sensitive instruments. Our losses in this area are minuscule. We have a much better record than any of our competitors, and we need to let customers and potential customers know about the quality of our services.

Allen: That sounds good. How much more do you need for advertising, and what kind of increase in sales would you predict?"

Strom: To do it right, I would need to double our current advertising budget. I would guess that sales would increase by $20\%.$ I also have another suggestion. I think we should look at the international goods and freight$-$moving market.

Many firms ship goods internationally, and I believe that they would switch to us if we entered that market. My preliminary analysis reveals that we could pick up $$500,000$ of sales during the first year.

Allen: Both suggestions seem to offer some potential for improving our profitability. Gautam, would you gather the data needed to estimate the effect of each of these two alternatives on our profits?

Singh: Sure. I have a suggestion also$$I plan to install a cost accounting system. At this point, we have no real idea how much each of our services is costing. I believe that there is some hope of reducing costs without affecting the quality of our services.

Allen: I$\text{'}$m all for reducing costs where possible. However, keep in mind that I don't want to lay off any employees yet. I like the idea of providing security to our employees. I would rather see everyone take a pay cut before we reduce our workforce. So far, we have been able to keep everyone despite the drop in our sales. I think it's a good policy. If these two ideas of Heidi's work out, no new hires may be necessary, and we have trained, loyal employees ready for the new business. Required: Suppose that Suzie Allen decides both to increase advertising and to enter the international market. Assume that actual sales increase by $10\%,$ with $$340,000$ of the increase coming from international sales and the remainder from the increased advertising. Using data from Requirements $1$ and $4,$ answer the following questions:

a$.$ How much did operating income change because of these two decisions?

b$.$ What is the profit change attributable to the advertising campaign? The international market? What is your recommendation for the coming year? Should the company continue these two strategies? Or should it do only one or neither? Explain.

c$.$ Suppose that the company achieved its target profit of $12\%$ of sales in spite of the less$-$than$-$expected increase in profits from the advertising campaign and the international market. The remaining increase in profits was achieved by cutting variable costs. What is the new variable$-$cost ratio?